NETGEAR, Inc. (NTGR) Q3 2018 Earnings Report, Transcript and Summary

Good evening. My name is Josh and I will be your conference operator today. At this time, I would like to welcome everyone to the NETGEAR Third Quarter 2018 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session [Operator Instructions]. Thank you. Chris Genualdi, Director of Investor Relations, you may begin.

Thank you, operator. Good afternoon and welcome to NETGEAR's third quarter 2018 financial results conference call. Joining us from the company are Mr. Patrick Lo, Chairman and CEO, and Mr. Bryan Murray, CFO. The format of the call will start with a review of the financials for the third quarter provided by Bryan, followed by details and commentary on the business provided by Patrick and finished with the fourth quarter of 2018 guidance provided by Bryan. We will then have time for any questions. If you have not received a copy of today's release, please visit NETGEAR's Investor Relations Web site at www.netgear.com. Before we begin the formal remarks, we advise you that today's conference call contains forward-looking statements. Forward-looking statements include statements regarding expected revenue, operating margins, tax rates, expenses, and future business outlook. Actual results or trends could differ materially from those contemplated by these forward-looking statements. For more information, please refer to the risk factors discussed in NETGEAR's periodic filings with the SEC, including the most recent Form 10-Q. Any forward-looking statements that we make on this call are based on assumptions as of today and NETGEAR undertakes no obligation to update these statements as a result of new information or future events. In addition, several non-GAAP financial measures will be mentioned on this call. A reconciliation of the non-GAAP to GAAP measures can be found in today's press release on our Investor Relations Website. At this time, I would now like to turn the call over to Mr. Bryan Murray.

Thank you, Christopher, and thank you everyone for joining today's call. Before we begin, I'd like to make a few comments regarding financial reporting and consolidation, now that the IPO of Arlo Technology is complete. Third quarter of 2018 results for Arlo Technologies are consolidated into NETGEAR's results, with the exception of the portion of the net loss and loss per share attributable to the 15.8% of Arlo's common stock not owned by NETGEAR. As stated at our financial Analyst Day in September, we currently intend to distribute our approximate 84.2% ownership position in Arlo to all NETGEAR shareholders by the end of the first quarter of 2019, subject to market conditions and other factors including final approval by NETGEAR's Board of Directors and other customary requirements. Following the distribution Arlo results for all historical periods including the quarter in which the distribution occurs will be reclassified into NETGEAR discontinued operations. Now turning to our quarterly results, third quarter of 2018 came in above the high end of our guidance, driven by the success of Orbi, cable modems and gateways, SMB switches and the Arlo business. Overall NETGEAR net revenue for the third quarter ended September 30, 2018 was $400.6 million, which is up 12.7% on a year-over-year basis, and up 9.2% sequential basis. This is a quarterly net revenue record for NETGEAR. NETGEAR net revenue by geography once again reflects our continued strength in North America. Net revenue for the Americas was $288.8 million, which is up 18.2% year-over-year and up 11.1% on a sequential basis. EMEA net revenue was $64.9 million, which is up 4.4% year-over-year and down 5.5% on a quarter-over-quarter basis. The quarter-over-quarter decline in EMEA was a result of the focus and success of Prime Day in the region from Arlo which comes at a higher marketing cost. On a channel sales out perspective we are seeing quarter-over-quarter growth. Our APAC net revenue was $46.9 million for the third quarter 2018, which is down 4.2% from the prior comparable quarters, and up 22.4% quarter-over-quarter. The year-over-year decline is primarily driven by a decline in Australian service provider revenue in anticipation of the upcoming introduction of 5G. For the third quarter of 2018, we shipped a total of approximately 5.9 million units, including 4.9 million nodes of wireless products. Shipments of all wired and wireless routers and gateways combined were about 1.7 million units for the third quarter of 2018. The net revenue split between home and business products was about 81% and 19%, respectively. The net revenue split between wireless and wired products was about 78% and 22%, respectively. Products introduced in the last 15 months constituted about 35% of our third quarter shipments, while product introduced in the last 12 months contributed to about 30% of the third quarter shipments. From this point on our discussion points will focus on non-GAAP numbers. The reconciliation of GAAP to non-GAAP is detailed in our earliest release distributed earlier today. The non-GAAP gross margin in the third quarter of 2018 was 31.3%, compared to 29.4% in the prior year comparable quarter and 30.2% in the second quarter of 2018. Total non-GAAP operating expenses came in at $97 million, which is up 37% year-over-year and up 9.1% sequentially. As discussed on our prior two earnings calls, we've been adding duplicate costs in anticipation of Arlo Technologies operating as a standalone public company. Our headcount increased by a net of 92 people to 1,200 total during the quarter. We are adding resources to the key growth areas of our business, in addition to adding resources, as Arlo Technologies begins to operate as a public company and expect to continue to add additional headcount during the fourth quarter of 2018. Our non-GAAP R&D expenses for the third quarter was 8.3% of net revenue, as compared to 6.2% of net revenue in the prior year comparable period and 8% in the second quarter of 2018. R&D is vital to our business and therefore we expect this instance to continue to grow as needed in absolute dollars. Non-GAAP operating margin for the third quarter was 7.1%, compared to 9.5% the prior year comparable quarter and 5.9% in the second quarter 2018. The non-GAAP operating margin for the third quarter 2018 includes $15.5 million of duplicate cost associated with the separation of Arlo and the corresponding dis-synergies created as we hired talent to duplicate certain roles as Arlo begins to stand up on its own. This compares to zero duplicate cost in the third quarter of 2017 to $5.1 million in the second quarter of 2018. Excluding Arlo Technologies, NETGEAR standalone non-GAAP operating margin for the third quarter was 12%, when including the benefit of transition services agreement with Arlo Technologies, and 10.3% when excluding the benefit of these agreements. Our non-GAAP tax rate was 18.1% in the third quarter of 2018. Looking at the bottom line for Q3, we reported non-GAAP net income of $24.9 million and non-GAAP diluted EPS of $0.76 per diluted share. As previously mentioned, this includes the Arlo Technologies loss for the third quarter, except for the 15.8% loss that is attributable to non-controlling interest. Turning to the balance sheet, we ended the third quarter of 2018 with $529.8 million in cash. This includes the $187.8 million in cash held by Arlo Technologies. Excluding Arlo, NETGEAR ended Q3 with approximately $342 million in cash. During the quarter we generated $33.8 million in cash flow from operations which brings our total cash flow generated of the trailing 12 months to $60 million. Additionally we used $6.5 million in purchases of property and equipment during the quarter which brings their total cash used for capital expenditures over the trailing 12 months to $23.8 million. We remain confident in our ability to generate meaningful levels of cash. In Q3, we spent $50 million to repurchase approximately 205,000 shares of NETGEAR common stock, an average price of $73.15 per share. At the start of our repurchase activity in Q4 2013 we had approximately 12.1 million shares. Our fully diluted share count is approximately 33 million as of the end of the third quarter. There are 1.8 million shares remaining under our approved buyback program and we planned to opportunistically repurchase our stock in quarters to come. Now turning to the results for our segments, the connected home segment, which includes the industry leading Nighthawk, Orbi, Nighthawk Pro Gaming, and Neo brands, generated net revenue of $194.7 million which is up 6.3% on a year-over-year basis and up 1.8% sequentially. Excluding sales to service providers' net revenue was up 18.4% year-over-year and up 13.2% sequentially. Both our Orbi Mesh Wi-Fi product and our lineup of cable modems and gateways were strong performers during the third quarter. As a result, we are pleased to see that we continue to hold 50% market share in the U.S. retail Wi-Fi products which covers Mesh, routers, gateways and extenders. The SMB segment generated net revenue of $74.7 million for the third quarter of 2018 which is up 20.7% on a year-over-year basis and up 5.5% sequentially. Our switching portfolio continues to power our results for SMB. Please note that the Q3, '17 period was particularly weak for SMB due to channel destocking around the world for our storage products. With the strength of our switching line up our market share in U.S. retail and e-commerce channel remains high at 60%. For Q3 results related to Orlo Technologies, please refer to the separate earnings release which was distributed earlier today but needless to say, we are very pleased with the reported performance particularly in terms of revenue growth, user acquisitions and paid subscriber growth. Before I turn the call over to Patrick, I'd like to discuss the actions we are taking to neutralize the cost impact of tariffs on our business excluding the Orlo business. First, it's worth noting that we operate the supply chain that is already to deliver supply not only by supplier but also by geography. While a significant amount of our products are produced in China. We also produced a meaningful amount of projects in Vietnam. The labor cost of manufacturing in China has increased in recent years, but we had already begun the process of moving production to lower cost locations prior to the recently implemented tariffs. We are now accelerating our process, obviously this is not something that can be implemented overnight, but we are moving very quickly. And we have experience in managing this. This will mark the third time that we have moved production locations and we are confident that the move will be complete by the middle of next year. Second, to further mitigate the impact of tariffs, we will be selectively increasing the prices of our products and expect that our competition will do the same. Using this strategy of increasing prices and moving our supply chain, we expect that we can neutralize the effect of the tariffs on our net income and EPS. As a result of the mitigating efforts, we believe that our targets for 2019 and operating margin dollars and EPS will be preserved. I'll now turn the call over to Patrick for his commentary after which I will provide the guidance for the fourth quarter of 2018.

Thank you, Bryan, and hello, everyone. We're extremely pleased with our results for the third quarter of 2018 which exceeded our expectations for both the top line and the bottom line. The quarter was driven by this success of Orbi, cable modems and gateways, SMB switches and the auto business. During the quarter, we completed the successful IPO of the Arlo business. I would like to acknowledge all of the hard work from both the Arlo and the NETGEAR teams that went in, to making this happen. It was no small task, but the two teams did a great job and Arlo Technology is now trades on the New York Stock Exchange under the ticker ARLO. Now as many of you know, in early September at our annual financial analyst day, we outlined our strategy for driving the NETGEAR business forward. The strategy is based on three key activities: Capitalizing on technology inflection points; creating new categories and building recurring service revenue streams. I would now like to spend some time speaking about each of these priorities. Since our founding we have been in the business of capitalizing on technology inflections. It is something that is in our DNA. Given our broad exposure from home to mobile to small businesses networking we see great opportunity to continue innovating and leading in the market. In the current quarter, you will see us aggressively introducing the Next Generation AO2.11 AX Wi-Fi product for consumers AO2.11 AX is the newest Wi-Fi standard that is optimized for accommodating many devices in the home. Reducing network congestion and mitigating neighborhood interference. The last Wi-Fi standard upgrade cycle was AO2.11 AC which began in 2012. Historically the release of each new Wi-Fi standard has created opportunities for the rise of ASPs and for us to gain share. Our AO2.11 AX Nighthawk router can handle four times the number of devices at 40% higher throughput deliver 50% longer range and improve the battery life of all client devices. We'll be incorporating 11 AX technology across our entire Wi-Fi portfolio, which will allow us to continue on the path of increasingly shifting our sales to the high end of the market. On the SMB side, both the move from 1 gigabit to 10 gigabit switching and the shift from POE to POE plus switching have driven ASP increases in our business over the last few years. More recently the transition from HDMI to Ethernet in the Pro AV audio-visual interconnect market has created an opportunity for us to innovate a whole new line of switches that are optimized for managing multiple large video display. 5G is another inflection point that we are positioned to take advantage off. It will completely change the landscape for mobile and on-premise connectivity. The evolution from LTE to 5G will provide speed and reduced latency, that is far better than what we have today. We can expect countless new imaginative applications to emerge that currently do not exist. We can also expect 5G to provide a viable alternative to fixed wireline broadband around the globe. We will be introducing 5G mobile hotspots in the current quarter and you can expect more 5G related products from us in 2019, both for the service provider and retail channels. Creating new categories is something that we try to do on a regular basis. And we have been quite successful in doing so, throughout our 15 year history as a public company. We were the first to bring wire free outdoor cameras to the market with the introduction available. More recently we were the first to bring to market a router with routing software, specifically developed for avid gamers. We were the first to develop switches, built specifically for the Pro AV market. If you joined us this year at our financial Analyst Day then you were treated with two of our newest innovations. The first is Orbi Voice, the industry's first Wi-Fi MASH hotspot with a speaker and voice assistant buildings. The second innovation is Meural a recent small acquisition that we completed during Q3, which is a hardware and cloud platform for the digital distribution calculated hard work. The Nighthawk Pro Gaming Router, Orbi Voice and Meural are all part of our newest category under Connected Home business, which we call lifestyle. We are confident in our market positioning and the unique value proposition of each of these product lines. Finally, I'd like to discuss on initiative to drive recurring service revenue. After a year of experimentation we are confident that we will continuously improve on our capabilities to build significant recurring revenue streams. This initiative provides the greatest opportunity to drive our operating margins higher. During the last year, we have been very active, getting our customers registered and engaged with us. We are learning more about our customers every day so that we can deliver the right services to them that fit their needs. Based on our historical shipment, data of consumer Wi-Fi routers, gateways and systems and our estimated replacement cycle time we believe that our installed base is approximately 25 million customers worldwide. About 9 million of them have already registered with us with a unique user ID plus all updated user credentials and NETGEAR product ownership. Half of them opted also for marketing messages from us. This represents a massive opportunity for us to tap into and deliver value to our customers in the form of services. We currently have five different services available to our connected home products customers and three different services for our SMB customers. Our goal is to get to 1 million paid service subscribers as soon as possible. The future for net gear will be focused on continuing to provide to our install base the innovation and internet connectivity they need, while creating the right value added services that are most desired by them. By being at the forefront of innovation in connectivity hardware supplemented by differentiated software, we will continue to command the premium end of the market, which will be key to successfully rolling out paid value added services to our installed base. I will now turn the call back to Bryan for the Q4 guidance.

Thank you, Patrick. For the fourth quarter of 2018, we anticipate revenue will be in the range of approximately $430 million to $445 million. Net revenue for the combination of CHP and SMB is expected to be in the range of $275 million to $290 million, while Arlo is expected to be in the range of $140 million to $155 million. Fourth quarter GAAP operating margin is expected to be in the range of negative 2.5% and negative 1.5%, which includes approximately $7.5 million of one-time cost associated with the separation inclusive of professional service fees for various advisory and other related costs. Non-GAAP operating margin is expected to be in the range of 2.5% to 3.5%, which includes approximately $21 million of costs to duplicate certain roles as the business begins - as Arlo begins to stand up on its own. Excluding Arlo, we expect the NETGEAR non-GAAP operating margins to be the range of 8.5% and 9.5%, which excludes any benefit from transition services agree with Arlo. Our GAAP tax rate is expected to be approximately 85% and the non-GAAP tax rate is expected to be approximately 22% for the fourth quarter of 2018. Operator that concludes our comments and we can now take questions.

[Operator Instructions] Your first question comes from Adam Tindle with Raymond James. Your line is open

Okay thanks and good evening. I just wanted to start Brian on Q4 guidance. Looks like you're implying revenue growth sequentially, ex-Arlo but Q4 operating margin down sequentially ex-Arlo. So why wouldn't we see more leverage. Are there additional costs that weren't there in the September quarter? I know you ran through some of there at the end, but I'm just hoping that you could maybe run through the buckets and how they compare to the last quarter on a sequential basis?

Yeah I think the big driver in the sequential movement in the non-GAAP operating margin relates to the Arlo business. You may have heard from the management team earlier that they're embarking and accelerating efforts to acquire end users. And as a result that's going to require some additional marketing dollars. So that's probably the bigger driver. Q4 is typically a very promotional season where we do make some investments in that area. Black Friday, Cyber Monday has grown from a one or two day event into expanding couple of weeks. So certainly a very promotional period of time.

And also as we've seen at, I mean looks like IT Camera is more seasonal and more promotional than the rest of our product line. So that's why it gets a bigger influence.

Right okay. So then the 2019 10% to 11% operating margin ex-Arlo that you outlined at the Analyst Day, is that also decreased or is that still intact?

It stays intact. As I said with regards to the tariffs, we are embarking on mitigating efforts to offset the type of operating income dollars as well as impact the EPS. Depending on how we approach that, it may change the percentage slightly. But again, we are committed to driving towards the same implied operating income dollars and EPS that we guided to probably in September.

Got it. Okay. And maybe just one quick one for Patrick. I wanted to ask little bit more on the distribution of Arlo. Can you maybe just talk about the logistics to this, and ensuring it doesn't cause significant volatility in shares? I mean what would prohibit a sale of the business instead and why not explore this given the market reaction to the IPO so far? Thanks.

No I think, basically the stock market is heavily influenced by lot of risk mentality. We still are very confident in the long term success of Arlo. I mean you cannot have better position holding about 40% plus of the market which is expanding significantly and at the same time expanding the product portfolio. And we just ship the doorbell. And they've added [ph] like and they actually will ship even more. I mean they also announce that you have another new category come CES. So I think there is nothing better in position for that. So we are still very confident that we're going to go ahead and there will be really good market acceptance of the distribution of the shares. So it is never come across our mind that we will change the plan anytime soon. But it was, I mean never say never anything happen, but for now the plan is to on and we're pretty confident we're still on that path.

Okay. Thank you.

Your next question comes from the Rob Stone with Cowen & Company. Your line is open.

Hi guys. I wanted to ask about the distribution as well. I guess you stated that you expected to be completed before the end of Q1. And I know that some of the necessary hurdles include getting most of companies fully separated making sure it's a qualifies for tax redistribution and so forth. Is it possible that you could still make a distribution before the end of 2018?

Definitely we're committing to the end of Q1, '19. Obviously we're working as fast as we can. But sometime between now and the end of Q1, '19 is what we're able to offer.

We feel lot of variables like moving locations, IT systems up and running. Customer contracts all tied up. So yeah, there is still a lot of work to do.

Okay. So sometime in Q1.

Absolutely.

And you mentioned that there is a significant amount of duplicate expenses in the fourth quarter including the time when you're providing some transition services to Arlo. So obviously your consolidated expenses that you report will drop once Arlo is spun off but can you give us a sense of how quickly you can then pare back these extra expenses, where you have just synergies and you're also providing services to Arlo. So how big a step down in core NETGEAR OpEx might we be able to see post the separation?

I think what we messaged at the analyst day is that we will experience some upward pressure on OpEx as a percentage of net revenues in the shared services functions just by way of taking it off the Arlo business in the topline. But again we remain committed to be able to deliver that double-digit operating margin for 2019 and believe that the underlying performance of both CHP and SMB gives us confidence in that.

Of course given the seasonality of the CHP business you expect that, it would be lighter in the first half and better in the second half in terms of operating margin percentage.

Okay, with respect to the tariff impact, it seems like it's going to be a problem for everybody since China is such a major supply chain location for companies in the markets that you serve. Can you give us a sense of what you expect the pricing impact might be just thinking about whether this would have any impact on end demand, obviously everybody has to raise prices that it shouldn't have a competitive effect necessarily but perhaps a dampening effect on consumer demand? So if you give us a sense of this of the scope of likely price increase.

Well first and foremost we said that a good chunk of our products are already produced in Vietnam and also not all our products are subject to tariffs, and then also not all of our products are sold in the United States. So when you pair all that one out after another so the impact is not a 100%. And what our objective right now are is to bringing as much product as possible in Q4 just to make only the 10% tariff on those products that are affected and then we try to minimize the import of anything that is 25% tariff. We expect that our move of the factories to be completed no later than middle of next year. So our plan is to import goods for the U.S. mostly in Q2 of next year, which hopefully will be completely tax-free even not a 10%. So of course, I mean, so if our plans got executed completely then the tariff effects when you're take in to all - that to account will be very minimal. So but still we need to offset that right. So we're going to raise prices but we're not going to do raise prices across the board with a fixed percentage. I mean we will surgically raise prices on products that we believe number one that people are less price elastic. Two, we have a unique advantage that people would pay for it. And thirdly that we believe that it would not dampen demand for that particular product. So that's why you know, put it all together. We're still pretty confident that the tariff would have minimal effect of achieving our full year 2019 operating margin dollars and EPS.

Okay and final question for you Patrick. I wanted to get some sense of you know, this is the quarter in which you're going to be introducing for the first time A02.11 AX as well as 5G products. But I imagine it'll take a while for both of those things to grow up their share of the overall revenue. So by when should we expect those inflections to begin to have a material impact, not asking for a specific percentage, but we just went when do you think we'll really notice that impact on revenue? Thanks.

Well given the fact that the ASP is going to be kicked up another notch, all right, generally speaking every year when we introduce some new technology the ASP get kicked up for that particular line of product, you know for 20% to 25%. So this is significant and because the introduction is not like selling online onesy, twoesy. We're introducing into the channels. And our revenues accounted on the shipment basis. So I would still say as far as Q4 is concerned is material. 11X and 5G from the revenue perspective is material. From a sales out perspective, we do agree with you, that it probably would take into the last part of the first half of next year to be material. However, based on our experience 11 AC pretty much overtook 11AC the 11N three years into the introduction. So I would say now we introduce 11 AX and 5G at the end of 2018. That means by 2021 during Christmas time, then pretty much 5G and like the 11AX will be the primary portion of our both shipments as well as filled out.

Great. That's super helpful color. Thanks.

Your next question comes from Bob Cihra of Guggenheim Partners. Your line is open.

Hi thank you very much. Just a couple of things. One Patrick, you didn't called out Nighthawk Pro Gaming Router I don't think in I just I wasn't sure if that was just because you can't call out everything or if that was not necessarily as strong a contributor. I mean clearly, it's a contributor year-over-year since you didn't have a year ago. So I guess I'm just curious how that's going with the refresh you had and that sort of thing. And then, separately on the service provider being weaker even than expected and in the long term that's probably a good thing. Was that all due to Telstra decline or was there was there something else and is that sort of $38 million a quarter is that now the kind of a new go-forward number of there was such a thing. Thanks.

Okay first questions, answer first. I think I did call out Arlo, I did call out Orbi, I did call out Pro AV. So I think not just NETGEAR Pro gaming, but on the Nighthawk line NETGEAR Pro gaming is the newest line of product. And furthermore my son is a gamer and my son-in-law is a gamer. So that's how it kind come to my mind first. But so they all performed really well. I mean the Nighthawk Pro Gaming clearly fits, it's well recognized and it's very high margin for us. And I mean we're very pleased with this performance. So we pleased that we introduced a second SKU and tried a new price point. We just introduced last week the premium pro gaming router at 499, and they sell, that is pretty cool. And so I think I mean that we are very, very pleased with it. And then in terms of the lumpiness of service provider sales from one quarter I won't look at it just one quarter. Because I mean they have their different priorities in CapEx and inventory position, which we look on an average four quarter basis was still pretty confident, it will stay in that range that we talked about around $35 million a quarter. Now I'm not them, I cannot speak for them. The only thing I could tell you is not Telstra only. And if I wouldn't, I would probably save some bullets for the 5G right. And I mean you know I mean 5G is coming why they're buying more 4G that is me saying. I'm not telling that I know exactly but that's how I'm guessing it. So that did I miss any questions.

No that's sounds good. And I guess just the last thing, is there anything else if you look at your domestic business and the service provider. I mean is the sort of I don't know hesitation or planning or whatever for 5G. Does that impact to you similarly or why the different Australia?

No, I didn't say that. I just said that I do not want to specify whether it's Australia or North America or Europe. It's hard to tell our customer. But I'm just saying that generally speaking all right, if I have a carrier and I know 5G is coming why should I load up more inventory on 4G I mean that's why?

Okay. And then last if I could to follow up just. Is there at what point that's obviously towards this quite early. But if you guys we're going to start reporting I guess services and actual services revenue number. I mean is that kind of the thing that's even on the horizon or is I mean you'd like to at one point, I guess by definition, that would mean that was it big enough that you'd want to import it, but I'm just curious when that might be the type of thing that you would actually call out in dollar terms? Thank you.

Sure, I mean it's pretty simple, I don't want to imply anything that the immaterial. So today's it's been material. Now how do I count it material, I wouldn't say purely on the top line, right because we're still primarily a hardware company I mean. Top line it would never be material, be 1% to 10% or something. But on the bottom line it's there, and you have to understand most our services are pass through basis, bit defender, for our armor, circle for our parental control, gaming, NETDUMA you know all these, we actually have very little operating expenses which would basically a cut on this. And because of that we only report it on a net basis on the revenue. So I would say by the time that the service revenue is contributing to more than 10% of our overall operating profit, then we'll probably start deploying it. That how I look at it.

Okay. All right. I'll look forward to that then. Thank you.

Yeah, hopefully very soon.

Your next question comes from Hamed Khorsand with BWS Financial. Your line is open.

Hi, First off, I wanted to ask you what about this 11 AX product and you were talking about your Analyst Day but you also mentioned that it could come out at the end of September or early October. But it's been delayed based upon that commentary. Was there a reason for that?

Yes, it's pretty simple, if the software is not up to our QA standard, we're not going to introduce it. And the software is, at the firmware that was primarily supplied by our chip vendors and they have to get it up to the stand that would believe that is solid before we introduce them.

Okay. And then as far as the SMB businesses concerned you were deciding some momentum in the switches. Is that a onetime event or do you think you can sustainable growth from here on at the $74 million level?

Yes, I mean would I'd have pointed out I mean the $74 million level is a pretty good go forward basis and we said that we're going to continue to grow and mid-single-digit on an annual basis and is powered by the switches and as we setting many times both in Analyst Day and all the calls. I mean the kind of switches this powering pounding our growth our POE plus to engage Pro AV and we don't see that will change in the near future. I think this trend will continue on for the next two, three years until, we, there is another new category that we're pushing and who knows, maybe in two, three years will be significant, we call it App Switches. All right, which is a new category that we introduced, and hopefully it will be a star in two, three years' time.

Okay. And then also just from a Q4 standpoint. You haven't really talked about any of your marketing plans or anything. So I'm assuming that you're comfortable with just on an ongoing basis, but you've historically done. Are you seeing a competitive threats on the horizon? Are you just keeping the marketing stable?

I think we said earlier that the Q4 is typically a more promotional season. So I think we're expecting it to be normal for that time of year. I think we also mentioned that the Arlo business is a little more seasonal, and given their push for acquiring users that they're going to be a little more promotional in Q4. So other than that, I think it's similar to what you would see in the Q4 period.

Okay. Now over the, from a competitive standpoint, my questions in general. I was really focused on NETGEAR, now Arlo?

Yes. NETGEAR, I expected to be similar behavior as we've seen in the past. A little more control revenue marketing focused in Q4 driven by the Black Friday and Cyber Monday promotional period.

Okay. Thank you.

Your next question comes from Woo Jin Ho with Bloomberg Intelligence. Your line is now open.

Great. Thank you for taking my question. So let me spin the service provider question around a little bit. So you're connected home service via business. That record revenues for the third quarter that since '14, '15. What was driving that strong sequential uptick in the quarter?

Again. I would, I point out the same thing, it's Orbi, is NETGEAR Pro - Nighthawk Pro Gaming, is the cable, those are the 3. I mean, it's pretty amazing that we were able to continue to drive the market forward.

Sure, okay. And then in terms of terms of your ability to pass through the tariff cost to the customers, part of that is your competitors and I believe you mentioned on the prepared remarks you competitors will follow suit on that but what gives you the confidence that your competitors will raise their cost, especially given that they want to take market share away from you.

Well, I mean, so of course, this is our reading of the market right and we have intelligence, we have our years on the ground and most contracts required you have to you know, let your distributors and your retailers no while price increases 90 days in advance. So we're well within that situation and furthermore I mean unlike us all our competitors have production a 100% in China. So talking about the ability to absorb carriers or pass it on we are in a much stronger position than out competitors and furthermore the fact of the matter is no matter which parts of products you talk about. We always come in at 25% to 35% premium anyway, so you could figure who would have the upper hand.

And then given all the factors in terms of the tariffs, your ASPs, your new products that are coming out in 2019, do you still have confidence on the 3% to 5% revenue growth targets for next year that you gave on the Analyst Day?

Definitely, I mean in one and the nuance is all the tariff tag on, is counted as top line.

Great, thank you.

Your next question comes from Trip Chowdhry with Global Equities Research. Your line is open.

Thank you, and congratulations on very solid quarter and a very solid guidance. I had a question on your outlook. Can you explain really what this product is? And what is the business model behind it? And since you acquired this company, how can we think about how the overall product will get evolved over the next two to three years?

Well, I mean this probably is pretty simple, I have been taking around the world showing it to customers showing to channel partner, showing to friends. There is not a single time that the person I show it to didn't say, oh, I want one. All right, so they gave me the confidence it's something that really people want. I mean you've seen it you love it, I mean and it's not just display of artwork but it's curation they curated the art where we've got all the explanation in the background and the quality. I mean, it's one of the magazine review has said it, it is so real that you really want to touch the brushes on it for crying out loud, it's an electronics banter. So that it's so real. So that's great all the hardware platform. But more attractive is in order to gain access, to those curated art you're going to pay all right on a monthly basis to the tune up about $4 to $5 a month depends on whether you are yearly or quarterly or monthly rate and they have a high attach rate, even though if you buy that canvas you get some freebies to begin with and the freebies are put it on good actually. However, there is do a high attachment rate for people to go beyond the - complete access of 40,000 and all the deals that they are still negotiating or I could get more curated art work, and the next stage of expanding the revenue business model is very intriguing. So we believe by combining the tremendous platform they have built with the worldwide distribution channels that we have is a pretty powerful combination and furthermore we can add a lot of technology to it. We're very excited about this and coupled with all the voice, coupled with NETGEAR Pro gaming. I mean it's a fantastic triumvirate of a lifestyle line of products in the house and nobody can rival that.

Although like when I look at the videos portraits and go to the art center's I do see there are many form factors of the artwork while currently [indiscernible] only has one form factor of the frame. Do you think down the road we may say a smaller form factor of the frame so that some artwork which is of a different size can be viewed in a different setting.

We are having a fantastic product plan in the future which I cannot disclose.

Beautiful. Do we - do you think we can see some updates from new round at the Consumer Electronic Show?

Absolutely. Please come.

Beautiful. Congratulations on a very solid quarter.

Thank you.

There are no further questions at this time. I'll turn the call back to the presenters.

Thank you for everybody joining today's call. We very pleased with the successful quarter in Q3. For all three businesses Connected Home, SMB and Arlo. We're excited even about more of the opportunities that are ahead of us and specifically in Q4. And I look forward to updating you all again on our next earnings call after very exciting holiday season. Thank you. Bye-bye.

This conclude today's conference call. You may now disconnect.